Most people find comfort in herds, which makes sense given the safety it offers in nature. However, this instinct can prove to be quite dangerous when it comes to investing especially when the motivation for joining the pack is based on the fear of missing out during rallies or the fear of further losses during corrections.

Therefore, while herds move markets, sectors or stocks, the key is to separate which ones are based on emotion or hype versus those founded on sound reasoning. In today’s environment there are plenty of examples of herding into and out of segments of the market creating both opportunities and risks.

Over the past year, investors and speculators have been crowding into the so-called reflation trade by betting on a global economic rebound back to levels experienced during the mid-2000s. This means dusting off the carry trade that worked so well during this period by shorting the U.S. dollar and investing into commodities and emerging markets. As a result, they have pushed the U.S. dollar index down nearly 12.5 per cent from its March 2017 peak.

Although there is no doubt a turnaround in global economic growth, we think it is far too premature for this trade as this cycle is very much different from the last one, with low levels of inflation despite strong employment numbers, significantly higher debt levels and central banks about to implement monetary tightening.

Meanwhile, the Bank of Canada has hiked rates three times in the past 12 months sending the loonie rocketing higher against the U.S. dollar. This comes at a time when NAFTA negotiations have yet to be completed, Canadian oil differentials remain quite wide, questionable employment data is being presented, and household debt is setting new records all of which could mean our dollar could face some downside pressure ahead.

Oil

The non-commercial or speculative long position in global crude oil and fuels currently totals more than 1.4 billion barrels, a level never seen before in the history of trading the commodity. Think about that: Speculators now own nearly 3.9 million barrels per day on the premise that oil prices will be moving higher. Interestingly, this is at odds with the futures market, which is in backwardation, meaning lower forward prices in the months and years ahead for those wanting to hedge out this irrationality.

We remain very concerned should this monster-sized spec-long position start to unwind. Look at what happened in July 2014 when the unwinding of what was then a record long position sent oil prices crashing from US$107 per barrel to a low of US$26 per barrel.

Interest rates

We find the level of hawkishness surrounding the Bank of Canada and the expectation for another two to three rates hikes this year to be quite astounding. Consequently, investors have reacted by dumping Canadian government bonds with the 3 to 5 year yields rising 240 per cent from 73 basis points in March 2017 to 177 basis points.

Other interest rate sensitive sectors such as utilities and telecommunications have also been affected. The S&P TSX Capped Utilities Index is down more than 8 per cent from its highs last summer (excluding dividends) while companies such as Enbridge and Canadian Utilities are down nearly 19 per cent and 15.5 per cent, respectively, over the same period. In the high-dividend-paying telecommunications sector, companies such as Rogers Communications and BCE Inc. are down more than 14 per cent and 8 per cent, respectively, since their highs last fall.

As you can see there could be some excellent opportunities for those willing to bet against the herd and some significant risks for those looking to join the herd. That said, this doesn’t mean one has to make a concentrated call against the crowd but rather take a prudent approach by diversifying a portion of one’s portfolio away from the herd, which may feel uncomfortable now but very rewarding later.

Martin Pelletier, CFA is a Portfolio Manager and OCIO at TriVest Wealth Counsel Ltd, a Calgary-based private client and institutional investment firm specializing in discretionary risk-managed portfolios as well as investment audit and oversight services.